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Saturday, 7 May 2011

Equilibrium of a firm under Short run and under long run in the monopolistic competition




SHORT RUN EQUILIBRIUM :- In the short run numbers of the firm remains the same. Each firm wants to earn maximum profit. Under monopolistic competition in the short run, some firms can fix the different prices.
Keeping in view their total cost . Some times, few firms earn abnormal profit than others by advertising their product.

In the monopolistic competition also, a firm is an equilibrium position when its marginal cost is equal to marginal revenue.

MC = MR

It will be the best level of output . In a short run a firm may earn abnormal profit or may suffer a loss. If a firm is earning losses but covering full variable cost the firm will continue the business. If variable cost not met the firm will close down in the short run.

It can be explained with two diagrams

1. Case of Short run abnormal profit :
EXPLANATION :- In this diagram the SMC curve cuts the MR curve from below at a point E. The firm produces and sells an out put OF as this level of out put MR = MC . The firm sells out put at OH price. The total revenue of the firm OHCF while the total cost of the firm is OLEF because the AC curve cuts at the point D.
The total profit is OHCF - OLEF = LHCE

2. Case of Short run Losses :- If the cost of production and market demand situation is unfavorable for the firm then it may suffer a loss. We can explain it by the following diagram :



EXPLANATION :- In this diagram Marginal cost ( MC ) curve cuts, the marginal revenue (MR) curve at the point E. A firm produce "OF" out put and sells it at "OH" price. The total revenue of the firm is OKCF. So the firm is suffering a loss.

Loss = OKCF - OHDF = HKCD

EQUILIBRIUM OF A FIRM IN THE LONG RUN :- In the long run the firms generally earn normal profit. In the short run if the firm earns abnormal profit, Then new firms will enter into the industry and profit will fall due to rise in supply. So abnormal profit will be converted into normal profit.
On the other hand if firms realize losses in the short run, then some firms will leave the industry and supply will fall.The price will rise and again firms will earn normal profit.
The equilibrium of price and out put in the long run is explained by the following diagram :


EXPLANATION :- In this diagram marginal cost (MC) curve cuts, the marginal revenue (MR) curve at the point L.. A firm produces OF output and sells it at OH price. The total revenue of the firm is OHDF. So the firm is earning normal profit.

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